Why Consumer Spending Is a Slow Motion Train Wreck

Retail sales were surprisingly good in April and May, but we believe this was primarily the result of the tax rebate checks–which will soon be spent. Meanwhile, consumers are likely to feel ever more strapped. Northern Trust’s Paul Kasriel shows why:

First, the wealth effect. Americans are a lot poorer than they were a year ago. Specifically, thanks to declines in home equity wealth, they’re almost $2 trillion poorer than they were a quarter ago, with $399 billion of that decline coming from the fall in real-estate equity:

Second, the loss of the gift that kept on giving: Home equity withdrawals. As house prices drop, Americans can’t spend the annual increase in home prices, which they had been doing aggressively for more than five years. Mortgage equity withdrawals (MEW) have now dropped to 1999 levels:

At an annualized rate, active MEW peaked at $576 billion in the second quarter of 2006. Active Mew has slowed to only $114 billion in the first quarter of this year – the smallest amount since the fourth quarter of 1999 (see Chart 3). There is no doubt in my mind that active MEW, which actually puts additional cash into the hands of households, played an important role in boosting consumer spending in this past expansion. And there is no doubt in my mind that the recent and likely continued decline in active MEW will play an important role in retarding consumer spending in this recession. Because it has been easier to borrow against the increased wealth in one’s house than in one’s stock portfolio, dollar-for-dollar, falling house prices will have a more important negative effect on household spending that will falling stock prices.

Bottom line, American consumers have lost their most reliable source of debt financing, and spending is suffering accordingly. With house prices continuing to crash, mortgage equity withdrawals are likely to continue to shrink, putting more pressure on spending.

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